CMA publishes digital merger retrospective and calls for views

Introduction

The CMA has published an independent report on digital mergers and launched a call for information with a view to updating its Merger Assessment Guidelines. On the same day, CMA Chief Executive Andrea Coscelli delivered a speech to the OECD/G7 conference in Paris, commenting upon the report and outlining the CMA’s approach to the digital economy. The report and Coscelli’s speech signal a toughening regulatory stance towards acquisitions by large digital businesses; with a willingness by the CMA to consider more speculative theories of harm.

Background to the report

In October 2018, the CMA commissioned the Italian economic consulting firm Lear to perform an evaluation of UK merger decisions in the digital sector. Lear’s report was published on 03 June 2019, taking on three principal objectives:

• reviewing the broad theories of harm considered by competition authorities when reviewing digital mergers,
• assessing whether decisions in UK digital merger cases have been reasonable, taking account of evidence available at the relevant time, and
• evaluating the "outcomes" of those mergers and whether they have produced detrimental effects.

Lear’s findings

Observations on digital markets and mergers

The report identifies a number of general characteristics of digital markets and mergers which, it suggests, should inform approaches to merger control analyses:

• Network effects - whereby consumers derive value from a product depending on the number of other users of the same product - can create concentrated markets and encourage competition for rather than in the market. This may incentivise incumbent players to pursue "killer" acquisitions, “with the goal of reducing potential future competition”.
• User volume and user composition are key to platforms, often offered free of charge and funded by advertising revenue, who seek to market more lucrative "exclusive", attention-grabbing views to advertisers (as opposed to consumers who can be targeted through multiple means).
• Data can be a key asset, with mergers that enrich an incumbent’s data pool being capable of strengthening that business’ competitive advantage and raising barriers to entry.
• A preponderance of "young" acquisition targets (four-years-old or younger) create difficulties for regulators seeking to understand the competitive implications of a transaction when the target is early in its "life cycle".

Review of selected UK digital merger decisions

Lear analysed five transactions: Facebook/Instagram; Google/Waze; Priceline/Kayak and Expedia/Trivago1; and Amazon/The Book Depository. For each, the report assesses both the methodology for the substantive analysis conducted by the CMA’s predecessors and the actual market outcomes generated by the transactions.

The report finds some fault with each of the substantive assessments, though it stresses that these are properly perceived only with the benefit of hindsight. So-called ‘gaps’ in analyses include:

• An incomplete analysis of the online advertising ‘side’ of two-sided markets. For Facebook/Instagram and Google/Waze, the report suggests that insufficient weight was placed upon the way these free-to-use services were monetized (with reviews concentrating upon the users’ side of the market); possibly leading the regulator to overlook potential competitive harm. More generally, the report suggests that understanding monetization strategies is important in shedding a light on the rationale of the merger from the parties’ perspective.
• Underestimating the competitive potential of the target. The report suggests that, in Facebook/Instagram the OFT (the CMA’s predecessor) may have underestimated Instagram’s potential to grow into a significant competitive force as a social network (Instagram’s userbase has since doubled in size from 14m in March 2015 to 26m in September 2018). For Google/Waze, the report suggests there was enough evidence for the authorities to conclude that Waze could have become a relevant competitive force, but that this concern was considered ‘too uncertain’.

The report also registers specific criticisms, such as the assumption that users would recognise a post-merger bias in search results in Priceline/Kayak and the failure to consider potential vertical foreclosure in Amazon/The Book Depository.

Despite concerns raised in respect of the analyses, the report does not identify that any of the mergers necessarily had detrimental outcomes for consumers. The report positively endorses the OFT’s assessment of the Amazon/The Book Depository transaction, which it finds was both “convincing” on the basis of evidence available at the time and appears borne out by the fact that Amazon has not substantially raised book prices after the merger. The report is most equivocal in respect of Facebook/Instagram, but still acknowledges that the merger has “generated significant efficiencies to the benefit of users and advertisers” which may compensate for a loss of competition.

Recommendations in the report and Coscelli’s comments

The report sets out recommendations in light of its conclusions on past reviews and digital mergers in general. A number of these were welcomed by Andrea Coscelli. In his speech he suggested that the report highlighted the need for an “evolution, not revolution” in CMA practices.

A number of Lear’s recommendations relate to the definition of the counterfactual in digital mergers. The report suggests that the CMA should “accept more uncertainty” in the counterfactual and take a longer timeframe for the assessment of future market developments, beyond the current standard two-year forecast. This was endorsed by Coscelli, who suggested that the CMA should be more cautious in concluding that the absence of “compelling evidence” as to near-term market developments should provide grounds for clearance. Coscelli highlighted the need to use a more “dynamic counterfactual”, based upon how the market is likely to evolve.

The report also suggests that the value of a transaction should be used as a screening tool to identify those that may require more in-depth analysis, arguing that the transaction value “represents the magnitude of the effects (both beneficial and detrimental) associated to the transaction”. Endorsing this conclusion, Coscelli more explicitly suggested that a purchase price that is disproportionate to current or future likely earnings may suggest that the value reflects the “benefit of killing off competition” and therefore warrants closer scrutiny.

However, Coscelli was more circumspect in relation to a more radical suggestion in the report: making use of dawn raids to uncover evidence such as the future plans of the target and the acquirer’s perception of the target. Coscelli suggested that such raids should not be necessary, but that Lear’s recommendation underlined “the ever-increasing importance of the merging businesses’ internal documents to our assessments”. Coscelli leans more towards strong ex-post enforcement where merging parties provide incomplete or misleading information, as opposed to pre-emptive raids.

Comment

This report, as with other recent studies in the digital markets area, betrays a focus on big-name digital businesses (Coscelli referred to the GAFAM quintet in his speech) and concern as to perceived under-enforcement across the sector. The report’s general conclusions on acquisition trends in digital markets are based primarily upon the publicly disclosed acquisitions carried out by Amazon, Facebook and Google between 2008 and 2018; it is not obvious that this is representative of "digital M&A".

Regulators, particularly in the UK, are considering how to address cases of under-enforcement in relation to both transactions and anticompetitive conduct. The recent report published by the UK Digital Competition Expert Panel (the Furman Report) has called for guidelines to be imposed on firms across the digital sector more widely. Under the proposed regime, undertakings considered to be of "Strategic Market Status" would be obliged to comply with a new code of conduct. Importantly, this does not mean the firm has to be "dominant" under an Article 102 analysis. Rather, it would be considered economically irrational not to engage with that undertaking. In light of such proposals, a move toward an ex-ante approach to address under-enforcement seems, particularly in the UK, increasingly likely.

Generally, the CMA will see this report as chiming with its own views of how it should be assessing digital markets. The CMA’s recent provisional prohibition of Experian/ClearScore made a "dynamic analysis" of future competition and also relied heavily on internal documents to understand how the businesses themselves anticipated changes to the industry, as was explicitly highlighted in a CMA blog post discussing the merger and the CMA’s approach to merger control "in the digital age". Coscelli, meanwhile, pointed to the CMA’s provisional clearance of PayPal/iZettle as illustrative of how the CMA will approach "digital mergers" in the context of dynamic and contestable markets.

Coscelli made clear that he does not see the CMA making radical changes to its methodologies, speaking of "evolution", rather than revolution, in approach. Still, some of the proposals would have a significant impact upon the nature of merger reviews. The suggestion that the CMA should accept more "uncertain" counterfactuals and speculate as to how the market might develop will make it more difficult for companies to anticipate the CMA’s approach to a contemplated transaction. It may be challenging for parties to respond effectively to any theory of harm which is based on speculation as to both the competitive potential of a target and future changes in the nature of the market. At least, this report and Coscelli’s speech serve as a warning that large businesses buying digital start-ups will need to be able to justify the purchase price other than as a "buying off" of a potential competitor.

Finally, it is worth mentioning one of the more specific recommendations in the report; that the CMA should conduct a market study into the digital advertising sector. This dovetails with the Furman Report, which made the same recommendation. That market study is now looking increasingly likely.

Call for views on CMA Merger Assessment Guidelines

Coscelli used his speech to launch a call for information as to how the CMA should be looking at digital mergers. This is with a view to amending the CMA’s Merger Assessment Guidelines, which were last updated in 2010. If your business is interested in inputting to the CMA’s call for views, please get in touch with our UK competition team.

The Lear report is available here. A draft of Coscelli’s speech can be found here and the CMA’s call for information on digital mergers is here.

1 Expedia/Trivago did not meet UK thresholds for merger review, but is considered in the report alongside the Priceline/Kayak decision.